June 22, 2011
The answer, all too often, is about a year ago.
More often than not, privately funded technology firms miss the optimal jumping-off point and get swept over the waterfall from which it may take years to recover, if ever.
Rarely do investors and management teams jump at the right time. Even rarer still is the premature sale. The most common lament that I hear is, “I wish we had sold a year ago.”
Why has this sad ballad been heard over and over?
The Gartner Hype Curve
For venture-backed technology companies, the Gartner Hype Curve has been used to model the expectations surrounding emerging technologies over time.
In the early stages, venture-funded firms are almost completely evaluated on expectations. Hype, scarcity value, and protected intellectual property lift the company up the curve until around the B-round of venture funding, at which point strategic value (as opposed to financial value, as measured by a multiple of EBITDA) may begin to decline, sometimes swiftly, due to market coalescing, competitors, and execution risk. What lies ahead is the real, painful struggle to build a sustainable and profitable company. That part of the curve is much flatter.
Companies approaching the peak of this curve are often filled with good news: new products, expanding partnerships, and surging demand. With so much going so right, why sell?
Because small technology companies are heavily fueled by hope.
Hope of seeing a technology idea come to life spurs founders and early employees to make the necessary sacrifices. And the market loves to buy hope. When the future looks beautifully vague, investors are willing to pay many times over earnings for that future.
Yet in technology, hope cannot withstand much challenge. The triumphant wave of early success can be washed away by the arrival of a trumping technology. The entrance of an 800-pound gorilla into the market makes the route forward so much harder. Even the non-decisions, the forks not taken, can lead to a tumble over the cliffs.
Once hope flees the building, it’s hard to call her back. Where the unknown had been beautifully vague, employees and observers fill those information gaps with negativity. Attrition in the ranks erodes development. Media finds new darlings. Potential investors and partners get skittish. Down the backside of the curve we tumble.
The Core Problem
This moment is missed time and time again because management teams and investors often fail to plan ahead for the exit. For many senior executives, selling their baby may be emotionally difficult to do, so making plans to remove the company from their DNA can seem like a failure scenario.
They’re busy turning hope into something big and real. These moments of hesitation are often exacerbated by VCs who would rather swing for the fences than accept a financial return below the desired 10x multiple.
Then, what typically happens is some bit of bad news wakes everyone up. At a fateful board meeting, it is revealed that the company is running out of cash. Rather than further dilute their positions, the partners decide to sell the company. In a mad rush to beat illiquidity, negotiations are begun under a stinking cloud of desperation, hardly a strong negotiating posture.
Building the Solution
The discussion of exits must be raised early and often. The mechanisms for assessing current exit strategies and the mechanisms for executing those strategies should be laid out as soon as a management team is in place. Those plans should be regularly reviewed by a working group.
As the company evolves, part of the solution is to identify and cultivate potential acquirers. Your company’s most likely acquirer is one of your larger customers, so nurturing those relationships at a C-level can lead to easier and happier outcomes.
In the sub-$100 million category, buyers are looking for 2-3 consecutive quarters of solid growth where everything is trending upward. It is certainly possible to achieve successful outcomes before profitability.
If you receive an unsolicited offer, it’s a good time to test the market to see if there are other interested buyers. Stirring the pot is likely to build or solidify the market for your company. For best results, begin with a small number of firms with whom you have previous relationships or engagements, initiating the discussion with the business development teams – not corporate development.
These initial discussions should be formed around “looking for a strategic partner who may be interested in a commercial relationship and an equity position alongside that relationship.” The potential size of that equity position should take shape quickly. It’s important to have sufficient funds in the bank to say “no, thanks” to the first round of bidders if necessary.
As your company approaches the peak of the Gartner curve, when to sell your company depends heavily on your appetite for risk. When you’ve doubled your money at the blackjack table, are you the sort that starts looking for the cashier’s cage? Or do you settle in to double your money again – and risk losing it all? The answer depends on your appetite for risk and whose money and time you’re gambling with.